A disagreeable blog about Finance

Of Chinese pipe Dreams, and other distressed matters – Part 1

China has been brewing some kind of technical bubble, perhaps more than just one. Everyone knew this since the ‘90s. But it’s ok – people thought back then – they made a cozy high-growth platform out of themselves. They have an ample cushion to recover from any bubble. 

And indeed China went on to sell stuff. Selling everything like hot cakes. Their best selling item however has been the nice concept of a growth engine that can’t be stopped or stalled. After all, with US and European economies crumbling, China had a decisive role in restoring balance after the 2008 crisis. This narrative has been more than just nice, so far it has been dependable

Well, that, if you of course care to overlook the bad tide that has been in the making. 

But, life is hectic, you stop paying attention to the thing and suddenly it’s a lifetime later. You know, kids are married, your best output nowadays are farts and worst of all, you haven’t really updated a couple of critical reality views.

And then the bug joins the party. And Evergrande pops.

Evergrande decline. I mean, it’s not that one could easily miss it.
I mean, it’s not that one could easily miss it.

And just like that, the whole world starts smelling smoke, and develops some skepticism on the status of the 2nd largest economy. Suddenly you are like

Wait when was last time China did deleverage … anything?

Sacro, 2021

I used to check China vitals regularly before, but never with the frequency and depth that I use now. So where are we today? With this crisis? With the China crisis? 

Or is there even any kind of crisis in China? Of course not. Nothing to see here. 

Of course, the façade we are presented with, is trying to sell a very confident narrative. That of a China emboldened by its achievements and strong economic system. The digital RMB is going to become the next reserve currency.
No wait, let’s make another one.
And let’s have a kinetic war, for good measure.

But overall, the picture that emerges by just observing, is not good at all. Maybe the cracks in the Chinese Dream are starting to show?

In this series of posts, we will be dissecting the deadlock the CCP has forced China into, the fabric of the social construct that binds things together, and few other key pieces. I think it’ll be interesting.

But this being China, I bet there is no better way to start than with a view on what used to be 

The Real Estate market in China

I know people whose opinion about Evergrande doesn’t go much beyond “They did some shady stuff”.

The real estate sector in China has been pushed to the point of becoming more than a giant bubble.
It is now a literal pyramid scheme.

Literally an open secret (2000-something)

True, but that is a featureless building ground. It won’t work for our purpose here. So here is the bare minimum framework to understand what is happening and why. This is going to be quick, I promise:

So, prices of real estate assets in China have been growing without much of a rebound since around 1998.

Growth of real estate assets, China 2005-2020
Growth of real estate assets, China 2005-2020

Why? Because that is the asset people in China store their wealth in.
Question: Is there anything wrong with that? 

  • No? 
  • Perhaps? 
  • Yes? 
  • Lack of diversification? 
  • No? 
  • What do I know? I’m a guy on the Internet. 

But the point I’m making is that Chinese people were subject to a tremendous push to up real estate demand. And there are several drivers for it. More than I can list, but I’ll try: 


First, participating in the Real Estate market isn’t just a way to secure housing for the average Chinese. It’s way more than an investment. Owning a home, or better yet more than one, is basically the only way regular people have to save. To create a cache for their retirement. 
This has been the ideal (and only) path to financial security for them for a long time. Since private property became attainable.

It’s not that people had had any other choice if you think about it: filial support isn’t a realistic retirement strategy anymore, due to the effects of the One-child policy.


Second, owning real estate raises the social status of the family. It consolidates its achievements, efforts and sweat, into a physical manifestation of wealth and societal worthiness. It has a cultural impact much beyond what people in the west would be able to comprehend. For example, it is a very crucial selling point for individuals looking to marry and start a family. 


Third, as a consequence of the two above, one must secure a house unit and start to pay the mortgage as soon as possible. It’s just not an option to have money floating around. It would just get euthanized by inflation. People are more than happy to lend unused pockets of money in order to allow a relative to put down a down payment for a house unit. The more the better!

Now, just imagine the Fear Of Missing Out felt by society as a whole, to buy houses. As much as possible. And do you know what consequences FOMO has? 

It ups demand. 

Demand for more house units. 
Demands that always outpaces supply, causing the offer to be always too tight. 
And this drives prices even higher. 
Which in turn causes more FOMO. 

This doesn’t look like a bubble at all. And this is the context in which the story takes place.

Chinese Builders and their best practices

People in China compete, or should I say used to compete, in order to secure ownership of house units. Outbidding one another was just an established norm. There was no strong psychological ceiling to prices because of course the bigger the purchase, the bigger the yield. Prices can only go higher.

And purchase offers were put forward with such impetus that soon developers started to list units that only existed on paper, with construction works scheduled sometime far in the future. 

Cyberpunk 2077 PS4 release, patched
This is what I got from my presale.
(PS4 Release)

If you think game presales on Steam are bad, well, think about writing a down payment for an house that you have to wait five years to see, and paying the mortgage each month since day one. I bet that puts your Cyberpunk 2077 purchase on a different perspective right?

In 2005 half of all house units sold in China were sold in presale.
This number grew to 85% in 2020. The buying pressure was, and remained up to that point, mind-boggling.

China real estate capital allocation before 2008 crisis.
China real estate capital allocation before 2008 crisis. Note pre-sales already taking off.

And I repeat, presale doesn’t mean “Construction works are underway. Let’s check with our managers if you want to change decorations”. No. It means waiting the best part of a decade for the first bulldozer to show up.

Consequently, as the years passed, real estate developers accrued, and greatly expanded, their work backlog. This doesn’t bode well for how this story develops later on but, after all, their position can’t be that bad right? Developers have secured all the necessary funding, upfront. They are heavily capitalized.

Well, developers do settle land purchase from the local administrations. When they do that, then they immediately receive full payments for all the house units that are projected to be built on that specific land plot. The routine calls for all house units being sold immediately, as soon as they are announced. Huge cash injections!

At this point, builders are supposed to use the money from the sale to start construction right away. But that’s boring, and slow. And you have put on your payroll a bunch of people to do the job. 

No. There have to be a more creative ways to use that money right? 

Berlusconi. Italy's PM. Twice. Notorious scumbag.
… and this guy knows them all.

Of course there are. And here comes the moral hazard:

Why not make more land purchases instead?
The company will get even more money!
We will build stuff later.
The backlog is already huge, what difference does it make?

Evergrande, specifically the Team for Fantastic Outcomes – 2010’s

Now, I want to be clear on this: corruption in itself is bad, but not this bad. This type of move can only be unleashed when greed is pushing the cart, but it’s stupidity that holds the wheel.
As a consequence the entire industry’s business slowly transitioned into being configured like a Ponzi scheme.

You know what this behaviour does? It greatly amplifies the market offer of housing units, while giving people the impression that house units are hard to get. Because they actually are, if one has to wait years before the asset materializes. 

It maximizes the upfront transfer of money from the people toward the builders, exponentially amplifying profits during this mania phase.

And if you thought that was shady, there is more. The cherry on top is that developers listed houses that were already sold, as their property. Evergrande and its peers, like any other company, have a balance sheet. In it, all their assets and liabilities are listed, in order to get the total valuation of the company. These crooks used to list already sold house units under in balance sheet, to greatly inflate company valuations. A higher valuation unlocked more options for them in order to acquire more debt via loans and corporate bond emissions. What was used that cash for? Construction works?
Of course not.
More land purchases.

Sometime down the line the CCP decided to manage the problem.
But at this point it must have felt like asking a 4-year-old to stop a steam engine with a screwdriver.

And I’m sure someone in the CCP genuinely tried to do some good. But that someone wasn’t the one who decided instead, to put the local administrations in charge of the problem and call it a day. 

Local administrations were actually the worst possible choice for the job. They have an inherent conflict of interest: apart from rampant corruption of course, they derive more than 50% of their budget from land quota sales. 

You see where this is going?

Land quota sales. This is the way the CCP in China has allowed the local administration to exist. They are centrally subsidized only for a small part of their needs, and for the rest they are left to somehow fend for themselves. And what is their main revenue stream coming out of? You guessed it: Land quota sales, baby.

There is no way in hell for local administrations to put forward any kind of action in order to force real estate developers to cool down. No incentive at all. On the contrary, the faster land sales happened, more the money coming in for them. Which in turn is better for the local economy, and consequently for everyone. Demand is high!

The breadcrumbs trail continues on part 2 of this series.